6th Circuit Joins Majority, Accepting “Materialization of the Risk”

Last month, the 6th Circuit joined the majority view recognizing the “materialization of the risk” theory of loss-causation as an alternative to “corrective-disclosure” in securities litigation under Rule 10b-5.

The Public Securities Litigation Reform Act (“PSLRA”) and federal jurisprudence (Tw-Iqbal) require pleading specific factual allegations of each element of Rule 10b-5 claim, including loss-causation (a proximate causal relationship between not merely the alleged misrepresentation or omission and the transaction, but also the plaintiffs’ loss). Dura-Pharm, Inc. v. Broudo, 544 U.S. 336 (2005).

Under the “corrective disclosure” theory, the causal link between the alleged wrongdoing and the market loss stems from the market’s negative reaction to a corrective disclosure, either correcting an earlier misrepresentation or outing an omission.

In omission cases, the “materialization of the risk” theory, alternatively posits that negative investor inferences from a later event or disclosure caused the market losses and were a foreseeable materialization of the risk concealed or omitted. The “materialization of the risk” theory has been recognized by the D.C., 3rd, 4th, 5th, 7th, 8th, 9th and 10th Circuits.

In this case, Freddie Mac’s public statements glossed over the true extent of its exposure to the subprime housing market. That risk (and the losses) materialized when that subprime exposure came home to roost. The opinion is Ohio Public Employees Retirement System v. Federal Home Loan Mortg. Corp., No. 14-4189 (6th Cir. July 20, 2016).